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The slump

Key points are made on this page. For further information and details, take the link here [The slump: Details] or at the bottom of the page.

The numbers

Productivity growth, in MFP form, essentially disappeared after 2003-04 (Figure 1). The annual growth rate fell from 1.8% in the surge to next to nothing in the slump (from 2003-04 to 2014-15).

Annual average rates of growth (per cent per year) for the 12 selected industries group
The surge period is 1993-94 to 2003-04 and the slump period is 2003-04 to 2014-15
Calculated as differences in logs
Source: My calculations based on ABS Cat No.5260.0.55.002

Capital productivity showed the biggest turnaround, with a fall of well over 2 percentage points from its rate during the surge. The rate of labour productivity growth fell just over 1 percentage point.

Immediate contributors

A combination of slower output growth and more rapid input growth accounts for the disappearance of MFP growth. Figure 2 shows annual output growth fell from over 4.2% to 3.0%, while annual growth in combined inputs of labour and capital climbed from 2.4% to 3.0%. With the same growth in output and inputs during the slump period, MFP growth has fallen away entirely.

An acceleration in capital growth accounted for the more rapid growth in inputs. The capital contribution to input growth went from 1.8 percentage points during the surge to 2.5 pp in the slump (Figure 2). Labour's contribution declined marginally.

The combination of more rapid growth in capital and slower growth in output is the proximate reason for the steep fall in capital productivity.

Annual average rate of growth (per cent per year) for the 12 selected industries group

The surge period is 1993-94 to 2003-04 and the slump period is 2003-04 to 2014-15
Calculated as differences in logs
Source: My calculations based on ABS Cat No.5260.0.55.002

This combination is the central puzzle about the slump. Why was the capital acceleration left unrequited by output growth? It is unusual for capital to accelerate strongly over a long period -- 11 years in this case -- without a broadly matching acceleration in output. At face value, it does not make sense. It implies that businesses continued to up their investment, while average output and income returns declined.

The industry dimension is crucial to solving the puzzle. It turns out the mining industry accounted for roughly 60 per cent of the fall in the rate of capital productivity growth from the surge to the slump (2.4 pp of annual growth, as shown in Figure 1). The remainder of the fall was spread across a range of industries.

Underlying reasons

The construction phase of the mining boom played a very large part in the fall in Australia's capital productivity. The first question is, 'How did this happen?' and the second question is, 'How big a problem has it been?'.

To state the obvious, the boom in commodity prices led to a boom in investment in new mining capacity as miners chased the expectation of larger financial returns. The rate of capital accumulation in the mining industry jumped from 3.9% a year during the surge to 11.0% a year during the slump.

It is very important to note that, for productivity measurement, mining output is the volume of production and not the value of production. While a tonne of iron ore became much more valuable, it remained one tonne in volume terms.

Mining volumes did not accelerate to the same extent as capital, for three reasons:

investment lags -- when there is a rapid acceleration in investment, as in the boom, the ABS methods overstate the accumulation of capital in production because there is no allowance for the years in the investment process before mines, and therefore capital, becomes operational

rate of use of new infrastructure -- there was major investment in transport and other infrastructure for the long term that is underutilised in the short to medium term

depletion effects -- the capital requirements for mining have increased because deposits are deeper, more remote, less pure and so on.

The 'dash for volume' also reduced average capital productivity in the short term. With expectations that commodity prices would only remain high in the short term, it made sense for miners to get as much volume of product to market as quickly as they could. Inefficiencies could be tolerated, so long as high returns persisted.

Even though it has been over an extended period of around 15 years, the decline in mining capital productivity can be seen in the main to be the result of a process of adjustment to a shift in demand, a new set of expected prices and changes in the costs of extraction of mining commodities. A stable level of capital productivity would signal the completion of the adjustment process.

[I will say more on mining productivity as one of the 'Productivity issues', when I start populating that part of the site.]

There have been other industry contributors to the decline in capital productivity at different times and to different extents. While these cases are swamped by the mining case, they are still important. They are covered on the 'Details' page.

Consequences for living standards

The second question is about the significance of the productivity outcomes for living standards.

You would think the lack of productivity growth would be disastrous
for growth in living standards. On its own, it would be. But there was something
else going on.

Box 1 Productivity, the terms of trade and growth in living standards

We are concerned with real
income when we consider living standards – that is, income growth aside from
inflation effects. That’s why we focus on real (or volume) output and real GDP.
Real output growth translates into real income growth. And productivity, being
a real or volume concept, is a source of real output growth.

Another source of real income growth can emerge over the
short to medium term. Australia’s terms of trade rose substantially in the
2000s and provided the growth in living standards, when productivity growth
went missing.

The terms of trade are the ratio of export prices to import
prices. Export prices shot up from the early 2000s through commodity prices,
especially for coal and iron ore. Import prices fell because of the ongoing
trends in global markets and, in particular, because of rises in the exchange
rate.

While these are price effects, they had real income effects.
Higher export prices were a source of real income because they provided more
income per unit, relative to domestic costs of production. Lower import prices
were a source of real income because they increased the purchasing power of
domestic incomes. That is, Australians could purchase more goods and services
from a given income.

While productivity
is definitely the key source of growth in living standards over the long term,
there can be other sources in the short to medium term.

Growth in
Australia’s terms of trade – the ratio of export to import prices – filled the
gap left by productivity in the 2000s. See Box 1 for an explanation of how.

Australia’s
terms of trade began to take off from 2002-03. As a result, Gross Domestic
Income (GDI) began to depart from GDP (Figure 3). GDI is a measure of real
income that adjusts GDP for movements in the terms of trade.

The stronger growth in GDI translated into stronger growth in average income (GDI per capita) than if GDP alone is considered.

Figure 4
tells the story. It shows the rate of growth in GDI per person in the slump (up
to 2011-12) at nearly four tenths of a percentage point behind the rate in the
surge. That relatively small difference aside, it is the difference in
composition that stands out. While labour productivity was the major source of
growth in living standards in the surge, the terms of trade was the major
source in the slump (up to 2011-12). In fact, the additional terms of trade
effect very nearly made up for the weaker productivity contribution.

Annual rate of growth (per cent per year) -- GDI per person -- and percentage point contributions
Productivity is measured as GDP per hour worked
'Participation and employment' is the number of hours worked per capita of population
Source: My calculations based on data from ABS Cat No 5204.0

It was not just some random good luck that the terms of trade made up for the lack of productivity growth. The hike in commodity prices lifted the terms of trade both directly and through the exchange rate. And mining productivity, which was the major contributor to the productivity slowdown, fell as miners chased the higher commodity prices.

The year 2011-12 was chosen here because it shows the maximum terms of trade contribution. The terms of trade peaked in the first half of 2011-12.

The story has been quite different since 2011-12 with the fall in the terms of trade. This is picked up in ‘Recent developments’.

Forward page links

For further information and details on the material on this page, go to The slump: Details